Don't Go Chasing Waterfalls: Fiduciary Duties in Venture Capital Backed Startups

62 Pages Posted: 9 Nov 2020 Last revised: 22 Jan 2023

See all articles by Sarath Sanga

Sarath Sanga

Yale University - Law School

Eric L. Talley

Columbia University - School of Law; European Corporate Governance Institute (ECGI)

Date Written: October 31, 2020


We develop a model of venture capital contracting and use it to evaluate an emergent set of judicial precedents in corporate law, which we label the Trados doctrine. In our model, founders hold common stock while venture capital investors hold convertible preferred stock. We show that preferred shareholders have inefficient incentives to liquidate low-valued firms and to continue high-valued firms, while common shareholders inefficiently favor the opposite. The extent of incentive misalignment depends on the firm's intrinsic and outside valuations, and it is most severe around preferred's liquidation preference and conversion point. Although legal liability rules can rectify these misalignments, they can only do so categorically when management prioritizes {preferred} shareholders' interests. The Trados doctrine, however, generally obligates management to prioritize common shareholder's interests. Our model offers a precise mechanism for how capital structure, corporate governance, and legal doctrine jointly determine firm value.

Keywords: Venture Capital, Preferred Stock, Fiduciary Duties, Liquidation Preference, Conversion Rights, Contract Design, Corporate Governance, Efficient Breach

JEL Classification: G30, G34

Suggested Citation

Sanga, Sarath and Talley, Eric L., Don't Go Chasing Waterfalls: Fiduciary Duties in Venture Capital Backed Startups (October 31, 2020). European Corporate Governance Institute - Law Working Paper No. 634/2022, Available at SSRN: or

Sarath Sanga (Contact Author)

Yale University - Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States

HOME PAGE: http://

Eric L. Talley

Columbia University - School of Law ( email )

435 West 116th Street
New York, NY 10025
United States


European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels

Do you have negative results from your research you’d like to share?

Paper statistics

Abstract Views
PlumX Metrics